At 9 am tomorrow morning, Fed Chairman Alan Greenspan and 11 other members of the Federal Open Market Committee (FOMC) will sit down in the two-story, chandeliered Board Room at the Fed’s Eccles Building in Washington, D.C.
They will debate for about five hours — considering the state of the economy, the likelihood of inflation, and the decline in the dollar.
And then, they will change history.
Rumors Flying Of Half-Point Rate Hike
Until just a few days ago, nearly everyone still believed that they would do no more than announce another meager quarter-point hike — just like they’ve 
done six times in a row, following each of the last six Fed meetings.
But now, rumors are flying that the Fed could be more aggressive, jacking up rates by a HALF percentage point … potentially sending U.S. bond markets into a tailspin … busting the stock market wide open … and marking the beginning of one of the greatest interest-rate rises in our lifetime.
Already, short-term rates have risen to their highest level in nearly four years.
Already, in just the past month, U.S. Treasury bond prices have been slammed down by SIX FULL POINTS — a loss of about $6,000 per $100,000 in face value bonds.
And already, financial stocks — the first to get smacked by rising interest rates — have started to tumble.
What This Means To You
For most investors, this interest-rate surge spells danger.
- Just one year ago, when the situation wasn’t nearly as bad as it is today, long-term Treasury bonds fell a full 15 points, about a 13% loss for bond investors.
- Eleven years ago, also in a less severe environment, Treasury bonds fell even further — suffering their worst single-year decline in the history of our nation.
- In 1980 and 1981, U.S. Treasury bonds sold for as little as 55 cents on the dollar — off 45% from face value.
- And those are the kinds of losses that are possible in supposedly “safe†U.S. Treasury bonds. The losses that are possible in stocks, especially stocks that are directly susceptible to rising interest rates, could be even larger.
But for you, this interest-rate rise can bring opportunity — through investments that are designed to surge in value even as interest rates go up only moderately.
For example, consider the Rydex Juno fund — designed to go up 1% for every 1% decline in Treasury bond prices.
Plus, for more aggressive investors, I’m looking at interest-rate options, with the following characteristics:
- Approximate cost: $1,000 to $1,500.
- Implicit leverage: As much as 100-to-1.
- Goal: To profit from — or protect yourself against — rising interest rates.
- Downside risk: Even if you’re entirely wrong — even if interest rates don’t go up by one iota or actually decline — there’s no risk beyond your $1,000 to $1,500, plus any commissions you pay your broker.
- Upside potential: With a move in interest rates that is no larger than the one that occurred around this time last year — about one percentage point in Treasury bonds — I calculate these options could be worth $4,800 to $5,400. And with a truly MAJOR interest-rate move, such as I see coming, options like these could be worth as much as $15,000 to $20,000. If you had three of them (your cost: approximately $4,500), suddenly you’d have about $50,000.
This kind of high-leverage investment is not for all of your money — not even half or a quarter of your money. It’s strictly for money you can afford to risk.
But the most you can lose is the amount you invest. Not a penny more. It’s an investment that lets you sleep at night and yet can make you a not-so-small fortune.
I’ll show you how to get more information on this in a moment. But first, let me explain …
Why Interest Rates Are Set To Soar
No Matter What The Fed Decides Tomorrow
I want you to clearly understand the volcanic forces now driving interest rates higher, forcing the hand of the 12 men meeting at the Fed tomorrow, regardless of their views or desires.
We join an informal conference call among some of the 12 FOMC members that precedes tomorrow’s formal meeting. The dialog is strictly fiction — the product of my own imagination. But the facts are well researched, and the basic principles, indisputable.
With his opening comments, Chairman Greenspan sets the tone. “More so than ever before in history,†he declares, “the investors of the world will be watching us on Tuesday. We are in a deep valley, and they will be poised, waiting, like giant armies to the East and the West. If we do not do exactly the right thing — if we cannot find a middle ground between the extremes of hesitation and over-reaction — they will attack, and we could be overwhelmed. But where is that elusive middle ground?â€
The response to this and subsequent questions comes mostly from the president of the Federal Reserve Bank of New York, the branch that acts as the U.S. broker for foreign central banks.
“In theory,†he says, “we can talk about the middle ground until we’re blue in the face. But in practice, we can either raise our Fed Funds target by a quarter point … or we can raise it by a half point. There are no other choices.
“If we go with the half-point hike,†he continues, “what happens?â€
“We shock the system,†responds an unidentified voice on the phone.
“Yes, we shock the system,†he repeats like a seasoned college professor. “We shock the bond markets. We shock the stock markets. We shock the bubbling real estate market, the flailing domestic auto market, the highly-indebted consumer market. We shock the very essence of this economic recovery.â€
“And if we go with the quarter point?†asks the Fed Chairman.
There is a two-second pause, while the president of the New York Fed draws a breath. “Then, it will be the overseas investors that apply the shock treatment. As of the latest reckoning, the stats from the Treasury show that foreign central banks and non-governmental entities hold roughly $2 trillion in U.S. Treasury securities. Plus, they own another $1.8 trillion in other U.S. dollar-denominated bonds. Total U.S. bonds in foreign hands: About $3.8 trillion.
“And, right now,†he continues, raising his voice by an octave, “THEY ARE BLEEDING. They were already bleeding because of the sinking dollar. Now, on top of that, they’re losing money because of falling U.S. bond prices.â€
“What makes you think they’re going to start selling?†asks the unidentified voice.
“That’s the great fallacy that many commentators seem to be stuck on. The fact is, foreigners don’t HAVE to start selling to have an impact. They don’t even have to stop buying. All they’ve got to do is allocate a slightly smaller percentage of their international portfolios to U.S Treasuries … and the impact could be severe, very severe. That’s what China’s central bank is intimating. That’s what South Korea and Japan are also hinting.â€
“What do they want from us? Do we really know?†asks the Fed Chairman rhetorically.
“Our New York Fed deals with them every trading day of the year. We know exactly what they want. They want assurance that the dollar will not collapse, which can only come with sharply higher U.S. interest rates. Plus, they want much more yield on their investments, which also means sharply higher U.S. interest rates. And they’re saying to us: ‘Either you give it to us voluntarily. Or we’re going to come in and take it.’â€
“There’s obviously an instability in this situation, an imbalance of unprecedented dimensions,†comments the Fed Chairman softly. “The question that will be before us tomorrow is: ‘Is it a chronic instability we can watch or an acute instability we must react to now?’â€
“Both,†retorts the New York Fed president. “And we all know exactly where it comes from. It comes from the fact that, to finance our budget deficit, we must sell about one and a fraction billion in new Treasuries, over and above refunding operations, EVERY DAY …
“It comes from the harsh reality that at least HALF of that new financing must now come from those overseas investors … PLUS …
“It stems from the fact that, to cover our TRADE deficit, we must sell them TWO billion dollars of U.S. dollar investments per day …
“So you can see how almost any hesitation on their part — even if momentary, even if minor — can have adverse consequences.â€
“Bottom line?†asks the Fed Chairman.
“If WE don’t jack up our rates by a half point … THEY will jack up our rates by a half point — or more. The only difference: In the first scenario, we are pro-active and may still be able to retain control of the situation. In the second scenario, we will be mostly reactive and we may lose control of the situation, like we did in the days before Paul Volcker.â€
Silence reigns momentarily, followed by the faint chime from a distant telephone switching device. Then the Chairman speaks. “But we all know we don’t have the inflationary conditions that forced Volcker to drop his bombshells a decade and a half ago.â€
“No, not yet,†responds the New York Fed president. “But we have crude oil busting through the $55 barrier and surging to $57 per barrel this morning, higher in absolute dollar terms than they were in Volcker’s day …
“We have most commodity prices at new 25-year highs, the highest they’ve been since 1980, when Volcker stepped in aggressively …
“We have M-2 money supply growth off the charts, running at roughly DOUBLE the rate of those days …
“We have budget and trade deficits running amuck, FAR worse than they were back then …
“Ergo, we must either take aggressive action or, at the very minimum, we must clearly WARN of aggressive action to come. Otherwise, the scenario that will unfold will be uglier than any we could create.â€
The Chairman makes a final request: “Just for argument’s sake, describe that scenario for us.â€
“Dollar falls hand over fist. Dollar decline then brings bond decline … which, in turn, causes intensified dollar selling and still deeper bond declines. Market interest rates fly out of control. A panic cycle gets underway — a panic cycle that can only be stopped with Draconian measures. Measures like Paul Volcker had to impose in 1979 with multi-point discount-rate hikes and surcharges. Like he had to impose in 1980 with credit controls and still MORE multi-point rate hikes. Chaos reigns supreme.â€
Five Steps To Consider Taking Immediately
The fictional conference call ends here, but your time to make critical decisions is just beginning.
I hope you have begun to act on the steps I recommended in last week’s Martin on Monday. If not, it’s still not too late to do so. Plus, to help you along, I’m adding more details this morning …
Step #1. Get out of all long-term bonds now. That includes U.S. Treasury bonds, corporate bonds, mortgage bonds, even tax-free municipal bonds. It doesn’t matter if they’re high-rated or low-rated. It doesn’t matter if they’re guaranteed or insured. None of that protects you from the price declines that automatically reduce your net worth when interest rates go up.
The 30-year U.S. Treasury bond, for example, currently carries a yield of 4.82%. So, if you own a $10,000 T-bond, it will pay you just over $480 a year in interest. The 10-year note currently pays 4.52%. But if these bonds and notes fall just 10% in value, that’s enough to wipe out about two years of income. And if you continue to hold, hoping for a recovery, you could wind up losing four or five years of income.
Step #2. Keep the bulk of your keep-safe money in short-term Treasury bills (12-month maturity or less) or in an equivalent money-market fund. Treasury bills are still the safest place for your cash in any panic, bar none. You can buy them directly from the U.S. Treasury Department through their Treasury Direct program or you can buy them through a money market mutual fund specialized in short-term Treasuries or equivalent.
Step #3. Protect yourself — and profit — from a dollar decline with specialized mutual funds designed to rise with major foreign currencies. (See my monthly Safe Money Report for details.)
Step #4. Make sure you’re hedged against inflation with an allocation to the gold and energy sectors. They may suffer a modest setback if the Fed jacks up interest rates sharply, but it’s highly unlikely that just one Fed move will end the raging bull market in inflation hedges. So hold on tight.
Step #5. For money you can afford to risk, consider my Interest Rate and Currency Trader service — for those powerful interest-rate options I told you about at the outset. I introduced this service to you in last week’s issue of Martin on Monday, and our phones have been ringing off the hook ever since. Now there are only 376 of the original 1,000 slots remaining. To get on board, you can order a one-year subscription ($5,000) or a monthly subscription ($450). Or call Lloyd at 800-815-2917 for more information.
Markets Are Not WaitingThe next Fed meeting is tomorrow, March 22. After that, there’s going to be another Fed meeting on May 3.One way or the other, interest rates are going to start moving up.
My final word: With the upward pressure on interest rates now so powerful, interest-rate moves that normally take years could be over in a matter of months. To take advantage of the situation, you must have your investment strategies in place, sitting there BEFORE the market starts to move more rapidly.
Good luck and God bless,
Martin
P.S. Next Monday, I will turn to a topic that is even more important than money: How to enjoy your wealth with long life and vigorous health. So stay tuned.
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